Wall Street can't seem to see through Lululemon

Put aside its epic fashion-trend story, or the fact that the company was one of the first to make it socially acceptable for women to wear gym clothes while drinking a 600-calorie Frappuccino and smoking a cigarette outside of a Starbucks.

It has, for better or for worse, helped to usher in a look that people undoubtedly want to buy.

And that was the company's story this week, when it victoriously reported comparable-sales growth of 10% for 2015. Wall Street loved it, and Lululemon's stock popped.

But that's only half of the story, and it's not the most important half either. The story that really matters at Lululemon is a story of declining profits and ever increasing promises — of supply-chain issues and a major slowdown in innovation.

"This would be the fourth year in a row of gross margin and operating margin erosion," Laurent Vasilescu, an analyst at Macquarie, told Business Insider over the phone. "It's a top-line story right now, and people buy it on sales growth."

The question is, with numbers like the ones we're about to dig into, how long can Lululemon keep telling the same growth story before Wall Street sees through it?

Plus, they insulted Beyoncé (but we'll get to that later). Lululemon did not immediately respond to a request for comment on this story.

Take inventory

This isn't rocket science. For a retailer to turn a healthy profit, its sales need to keep up with the inventory it has on hand, but with Lululemon that's not the case. Inventory levels have been rising for years now.

Macquarie

Back in 2014 the company blamed some of that lag on a snafu at one of its West Coast ports. But that overhang should be gone now, and 40% of Lululemon's goods are shipped around by airplane anyway. Right now, according to the company, it's holding about 115 days worth of inventory.

And quarter after quarter, management has promised to get inventory levels down, but it keeps pushing back the whole "when" part. Here's what they said during Q3 earnings:

It will be into Q1 before we're able to fully align inventories with our forward sales trend. And I'm excited that by Q1, we could stop talking about inventory overhang. So, the bottom line here, we're very confident that the excess inventory is contained and that we have an orderly plan to exit that inventory and align our inventory balances by Q1.

Months later, inventory levels are "still elevated," as CEO Laurent Potdevin admitted on last week's call, and that's eating into the company's gross and operating margins. Lululemon's operating margin was sitting at 28.7% in 2011 (which ended in January 2012). It had declined to 17.9% at the end of 2015.

The company's operating margin declined again in the latest quarter. Even so, the company maintains that by the end of the year margins will look healthier because it will bring inventory in line with sales.

So how do you grow?

Now none of this to say that sales haven't grown. They have.

But they've grown because Lululemon has opened a bunch of stores — 61 in 2015 alone. Meanwhile, comparable sales at the stores the company has had open for more than a year are being guided into the low single digits.

"Store productivity is declining so they are chasing sales by opening more stores — rather than make their existing stores generate more revenues in our view," Macquarie's Vasilescu said.

Part of that is because old stores aren't as productive anymore. In 2015, sales per square foot in Lululemon stores fell 8% from the same time a year before, according to Macquarie. Costs like rent, on the other hand, are not going anywhere. Lululemon plans to open more stores in 2016 too — about 40.

This is the kind of stuff you see when everyone is wearing activewear.YouTube

The backdrop

Meanwhile, all of this is going on while more and more retailers are jumping into the activewear market. All the old-school athletic retailers (like Nike) are adopting this look, and as of March 31, even Beyoncé is stepping into the game. Lululemon did not have the best reaction to that.

It tweeted (and then deleted): "They do say imitation is the best form of flattery. Maybe Beyoncé is so Crazy In Love with our brand, she made her own."

Beyonce's fans immediately took to the internet and threatened to put Lululemon out of business. Some of the tweets highlighted issues with Lululemon's brand and body image, others pointed out that Lululemon (at this point in the history of activewear) is the old brand in the room.